Six months after the onset of the coronavirus pandemic, many merger and acquisition transactions remain delayed or sidelined. As companies report their Q2 financial results, investors are also focused on opportunities to acquire promising businesses that may face near-term financial and operational challenges, at lower valuations than were available prior to the pandemic. While these deals may appear to be hard to come by, shrewd investors will be well served by considering both out-of-court and bankruptcy acquisitions of distressed companies. This client alert describes some of the fundamental deal considerations, and highlights the pros and cons, associated with each of these strategies.
Out-of-Court Acquisition
- Often structured like a normal asset deal.
- Due diligence is even more critical to understand, and where possible, avoid and creatively address, potential liabilities.
- Specify assumed liabilities and excluded liabilities.
- Include indemnification and escrow where possible (but seller might not be able to perform under indemnification).
- Negotiations with creditor constituencies can reduce exposure.
Pros:
- Fast, no court approvals required.
- Less expensive than a court process.
- Buyer can sometimes achieve more control/certainty and purchase protections than in a court process.
- Can obtain traditional M&A protections (e.g., escrow, rep and warranty insurance, indemnity).
- Typically does not require an auction with competitive bidding.
- Potentially easy on customer/supplier relationships (subject to contract terms).
Cons:
- Cannot “cherry pick” contracts as easily as in bankruptcy.
- Cannot force support from and bind non-consenting creditors (e.g., lenders).
- Risk of possible successor liability (vs “free and clear” sale in bankruptcy).
- Need shareholder consent.
- Fraudulent transfer risk where seller does not receive reasonably equivalent/fair value while insolvent, but consider these protections:
- Arm’s-length sale process with consents of key parties.
- Valuation opinion.
- Structure through a friendly foreclosure/Article 9 sale.
Bankruptcy Sale
- Buyers often seek to avoid possible successor liability and other risks and require the sale to occur in a Chapter 11 to maximize buyer protections/rights.
- Section 363 of the Bankruptcy Code permits a debtor to sell substantially all of its assets if supported by reasonable business judgment, free and clear of all liens, claims, and encumbrances.
- Section 365 of the Bankruptcy Code permits a debtor to assume and assign, or reject, certain contracts and unexpired leases notwithstanding restrictions on assignment in such contracts.
- Upon a bankruptcy filing, the “automatic stay” arises and protects the seller’s assets from creditor collection efforts and contract terminations to enable a transaction to occur.
Pros:
- Court approved sale is “free and clear” of liabilities and balance sheet is clean.
- Shareholder approval not required.
- Eliminates fraudulent transfer risk.
- Enhanced successor liability protection.
- Contracts can be “cherry picked” and bad ones left behind, regardless of consent.
- Fast (sales can be approved within 30-60 days after a bankruptcy filing).
- Closing likely regardless of objecting creditors.
- Buyer can achieve “stalking horse” advantages: enhanced information, bid protections to protect itself and enhance purchase prospects (e.g., breakup fee (~3-3.5%) and expense reimbursement, and bid increased by same), minimum bid increments and tight timeline for the sale.
- Tactic: If buyer owns secured debt – it can credit bid for increased control.
Cons:
- Sale will be to the “highest and best bid”; an auction is generally required and, notwithstanding stalking horse advantages, marketing process may yield an alternative winning bidder.
- Secured lender can credit bid its debt to set the floor.
- More expensive than an out-of-court acquisition.
- Unsecured Creditor Committee appointed in Chapter 11 may delay sale and seek to extract more value.
- Purchase is “as is” – diminished escrow/no indemnity.
For more information on acquisitions out-of-court and in bankruptcy, please contact Ann Marie Uetz, John Simon, or your Foley relationship partner. Foley has created a multi-disciplinary and multi-jurisdictional team to respond to COVID-19, which has prepared a wealth of topical client resources and is prepared to help our clients meet the legal and business challenges that the coronavirus outbreak is creating for stakeholders across a range of industries. Click here for Foley’s Coronavirus Resource Center to stay apprised of relevant developments, insights and resources to support your business during this challenging time. To receive this content directly in your inbox, click here and submit the form.
